How To Refinance a Home
Refinancing a Mortgage: Everything You Should Know
There are a number of reasons to refinance your mortgage -- maybe you want to lower your monthly payment, shorten the length of your loan, or want to tap some of the equity you have in your home.
Refinancing your home is simpler than getting a new mortgage, and it doesn’t need to be stressful or overwhelming, as long as you know what to expect and understand. Armed with this knowledge, the process can be enjoyable and the outcome financially beneficial.
Editor's note: This refinance guide is provided by Reali as an educational resource for borrowers. Not all of the products mentioned in this guide are offered by Reali. We think it’s important that you, as a borrower, know your options in order to make an educated decision about your home loan needs.
What does refinance mean?
Refinancing a mortgage means paying off one home loan using another home loan.
Why Should I refinance my mortgage?
To know when to refinance your house, you only need to understand the potential benefits you may gain. These benefits are called “net tangible benefits,” and under conventional lending, the lender must show that the borrower is receiving a net tangible benefit in order to move your refinance forward. Here are common reasons why people refinance:
- A lower monthly bill (this can be done by casting the loan over a longer term, starting a new term, or by going with a lower interest rate)
- More favorable terms (e.g. fixed vs. adjustable interest rate)
- A lower interest rate
- Access to cash for a large expense or to pay off higher-interest debt
- Change mortgage companies
- Remove someone’s name from your mortgage
That’s really all there is to it. Of course there are details — a lot of details, to be honest — but we deal with them one by one, so you can understand more easily. If there’s something you don’t see addressed in this guide, reach out to Reali -- we have real humans who can answer all of your burning home loan questions. You can call us here: 1-855-846-7334
The benefits of refinancing
Lower your monthly payments
If your current monthly mortgage payment is overwhelming, or if you want to lower your payment so you can use the money elsewhere, then a loan refinance can help. You can reduce your monthly payments by securing a lower interest rate or by increasing the number of months you have to repay the loan (or both).
Lowering your interest rate without extending the loan saves money both in the short term and the long term. Your payment is lower, and the payoff date remains the same.
A new mortgage with an extended repayment period can also reduce your monthly bill, since extending the repayment period would spread the total amount you owe by more months to pay it back. The potential downside to extending the loan term generally means paying more interest over the life of the mortgage.
Lower your interest rate
When you first purchased your home, your bank or lender drew up a mortgage agreement based upon your financial situation at the time. Younger buyers often lack the time and experience necessary to achieve an outstanding credit score, so the rate may not have been the best. Or perhaps market conditions have improved since you got your loan and lower rates are now available.
Mortgage lenders don’t like risk, so they hedge their bets. One way they do this is to assign higher interest rates to mortgages for borrowers who are viewed as risky. You may be seen as a lower risk today than you did a few years ago, so you might qualify for a lower rate.
Increased interest cost over the life of the loan may be worth it to you if you need more cash in your monthly budget right now.
What is a cash-out refinance?
A cash-out refinance is a way to convert home ownership into spendable cash. The loan is made against the equity (e.g. outright ownership) you have in your home. You get cash and a bigger loan.
What is a rate and term refinance?
A rate and term refinance is the refinancing of an existing mortgage in order to change the interest rate and/or other loan terms without advancing any new cash to the borrower.
For example, if interest rates go down, a borrower might refinance at the lower rate. Or if a borrower has an adjustable rate loan, she might want to refinance to a fixed rate.
Fixed or adjustable rate mortgage
In a fixed rate mortgage, your interest rate is “locked in,” meaning that changing market conditions will not affect the monthly amount you pay in interest.
The advantage of a fixed rate mortgage is clear: if interest rates in the mortgage market go up (as they are expected to do in the near future), you will not pay more as a result.
The potential disadvantage is obvious -- if interest rates in the mortgage market go down, you will still be locked in to paying the higher rate you accepted at the start of your mortgage.
A government-backed mortgage is a home loan that is guaranteed by the federal government.
In other words, when you borrow money from a private lender that issues you a government-backed loan, the government guarantees repayment to that private lender in case you fail to pay the lender back.
The most popular types of government-backed mortgages are the FHA loan, the VA loan and the USDA loan. They all have different eligibility requirements and limitations.
Why does the government guarantee loans? Lenders don’t like financial risk, so they may charge a high interest rate, present very stiff repayment terms, or refuse to make a loan — all in an effort to minimize the possibility of losing money. This is especially the case when dealing with borrowers who have limited financial resources.
Many government programs are available to help guarantee home loans for middle to lower-income buyers, perhaps most notably through the Federal Housing Administration (FHA).
The government promotes homeownership, because homeownership is good for the economy as a whole. In order to promote homeownership, the government makes repayment guarantees that help private lenders sleep at night. This helps you convince those lenders to loosen up their purse strings. Everybody wins.
15- or 30-year mortgages
Most mortgage borrowers apply for a 30-year mortgage. The borrower (that’s you!) pays the lender back, with interest, in monthly installments over a period of 30 years.
The 30-year mortgage is so common that many borrowers do not realize there are other alternatives. The most common of these other alternatives is the 15-year mortgage (but the actual loan term can be whatever number of years you agree upon with your lender).
A 15-year mortgage is just like a 30-year mortgage, except that you pay back the loan in half the time. This raises the monthly bill, but not by as much as you’d think. Even though the loan period is cut in half, the payment doesn’t double. In fact, the payment tends to be only about one-third higher.
The borrower wins big on interest costs over the life of the loan.
Since you are borrowing the money for half the time in a 15-year mortgage as compared to a 30-year mortgage, you will pay less than half of the interest you would pay to borrow the same amount for 30 years.
The shorter the repayment term, the less the mortgage costs overall – so for most borrowers who can afford it from month to month, a 15-year mortgage is definitely a better deal.
Reali offers 10-, 20- and 25-year loan terms in addition to 15 and 30. Call us (1-855-846-7334) and ask which one makes the most sense for you.
A qualified mortgage is any home loan issued by a private lender according to federal standards meant to protect mortgage borrowers from lending practices that are deemed predatory or unfair.
In order for a loan to be considered a qualified loan, the lender must follow federal guidelines that forbid excessive fees and repayment terms that are difficult for borrowers to sustain (among other guidelines).
A conventional mortgage is any home loan not created or backed by the federal government. Conventional mortgages are created and backed by private lenders or government-sponsored enterprises, such as Fannie Mae or Freddie Mac.
Most mortgages nowadays are sold. In order to be eligible for purchase by Fannie Mae or Freddie Mac, the loan must be a conforming mortgage. That means the loan meets certain requirements.
The biggest difference between conforming loans and non-conforming loans is that conforming loans have a dollar limit. In 2017, the dollar limit on a conforming loan for a one-unit property is $424,100. In certain high-cost housing areas, that limit is increased by up to 50%.
A jumbo loan is a loan that exceeds conforming loan dollar amount limits.
Should you consider a cash-out refinance?
If you need (or want) a sizable loan for a home improvement project, a child’s education, or for any other reason, then a cash-out refinance might be an option. A cash-out refinance is a way to convert home equity into spendable cash. Here is an example:
Suppose you started your original mortgage a few years ago, and the value of your home has gone up since then:
- Purchase price: $200,000
- Original Loan amount: $160,000 at 4.0%
- Current appraised value: $240,000
- Number of payments made: 60
- Current outstanding loan balance: $145,000
- Your current equity: $95,000
You have been paying down your mortgage as the value of your home has increased. In both ways you have been establishing equity in your home.
Equity is just a fancy word that means “degree of outright ownership.” Simply put, the current value of your home, minus the amount you still owe, equals your equity.
The $95,000 is essentially your money, but instead of sitting in your bank account where you can use it right away, it is sitting in the market value of the bricks, mortar, and land that make up your home.
A cash-out refinance is a way to convert that equity into spendable cash without having to sell your home.
The amount of cash you can access depends on the loan-to-value limit set by the lender. If the lender allows a 80% LTV, for example, you could take $47,000 in cash. That amount would be added to the amount you already owe, for a new loan of $192,000.
Take someone off the loan
Things change. You may want to remove one person from a loan two people are currently responsible to pay. Divorce is a common reason to do this, but so is growth. Maybe you want to buy another property or finance another large purchase.
When a borrower is removed from a loan it means that person is no longer obligated to the monthly payment and borrowing power increases because the debt no longer factors into his or her debt-to-income ratio.
How do you remove yourself (or someone else) from a mortgage?
The most common option is for the remaining borrower to refinance the loan in his or her name only. This borrower will need to qualify for the loan independently.
Change from an adjustable to a fixed rate (or vice versa)
On a fixed rate mortgage, the interest rate does not change during the life of the loan. An adjustable rate mortgage is just the opposite: the rate goes up or down along with an index rate (there are many different index rates used by lenders).
Adjustable rate mortgages (ARMs) often come with a lower rate and lower monthly payment during the early years of the loan (the first five years, for example). This is great for a borrower who plans to sell the home or pay off the loan within that time frame.
Once benchmark rates begin to rise, however, an adjustable rate borrower who does not sell the home or pay off the loan may save money by refinancing with a fixed rate loan.
If you already have a fixed rate mortgage, maybe you’re spending more money than you have to. Like anything financial that fluctuates with the market, an adjustable rate mortgage involves a degree of risk, but it may make sense. It really depends on your financial situation, your plans, your current mortgage terms, the new loan terms and other factors.
How to refinance a home
You can learn the basics about how to refinance a mortgage without becoming a mortgage broker yourself. It’s all about being an educated consumer.
When the time comes to apply for refinancing, preparation is key to a smooth process. From deciding in the first place whether or not refinancing is for you, to shopping around for lenders and pulling together the necessary documents, the more you get out of the way up-front, the less stress you will experience during the refinancing process. Let’s go over what you will need to do in order to prepare for refinancing your home:
Do you know what your credit score is?
You should check your credit report and clear up any problems at least 60 days before starting the mortgage refinancing application process. Problems with your credit report might hurt your chances of getting the loan you want on the most favorable terms possible.
Most lenders will not start the loan application process unless and until all credit disputes are settled.
Appraise your home’s value
In order to issue a new loan, your lender will want to know your home’s value and how much equity you have in the home.
The first step in calculating the equity you have in your property is to figure out how much your property is worth. You can get a general idea by checking sites like Zillow. As you crunch the numbers, it’s a good idea to lean toward the low range of the value you think your home has. Your lender will send a professional appraiser to determine the value for loan purposes and it may not be the same as the value you find online.
This is why you must pay to have your home appraised by a professional your lender trusts. You do not get to choose who appraises your home.
During appraisal, present your home at its best. Once the appraiser is done, you will get a document that estimates the current value of your home.
Assemble neccessary documents
Unless you can do an FHA streamline refinance, you’ll need to provide many documents to your lender. This list will give you a general idea of what to gather. Your lender will give you its own list.
- Divorce or separation decree
- Transcripts or diploma if you don’t have two years employment
- Current housing documents (mortgage information)
- Tax papers
- Bank account information
- Assets information
- Employer verification
- Income verification
- Self-employment documentation
- Rental property information
- Title Insurance
- Homeowner’s insurance
You can apply with as many mortgage lenders as you want within a short time period without risking damage to your credit score from multiple inquiries. The rate-shopping window is 14 to 45 days, depending on the credit scoring model (each lender chooses the scoring model it uses).
Once a potential lender accepts your loan application, they have three days to offer you a Loan Estimate that shows the details of the loan they are offering you. Federal law requires lenders to give Loan Estimates in a standardized format designed to help borrowers compare one offer to another, side by side, without unnecessary confusion.
Refinance with bad credit
You should still research refinancing if you’ve got bad credit. First find out whether your credit is good enough to qualify for a loan that is satisfactory. If not, here are some of your options:
- Work for six months to improve your credit, and try to get into the next higher credit score range
- A cosigner with better credit may help you secure better terms than you can get on your own
- If you have an FHA loan, you may qualify for an FHA streamline refinance, which may not require a credit check or verification of your income and assets (depending on the lender)
How much does it cost to refinance a mortgage?
Refinance costs and fees
Even with a lower rate, a loan that comes with very high fees may be less worthwhile than it initially seems. The best way to uncover any hidden costs of a refinance is to run the numbers with potential mortgage lenders before you make a decision.
The good news is that lenders will likely compete for your business. Even when refinancing fees are factored in, you may still be looking at a substantial savings over your current mortgage.
That said, there are two things you will want to know before even considering a mortgage refinance: the cost of closing, and the break-even point.
Unlike traditional banks and brokers, Reali doesn’t charge fees. Specifically, we don’t charge origination fees (unless you buy down points), application fees or credit pull fees.
Cost of closing
Refinancing your mortgage may save you money over time, but the process itself can be costly.
In most cases, you can expect refinancing fees to cost between 3 and 6 percent of the outstanding balance on your original mortgage. In some cases you will need cash on hand to close the loan. In other cases, you will have the opportunity to roll those costs into the loan balance. If you do that, you will pay interest on those costs for the life of the loan.
The point where your cumulative savings equals the cost of your loan is called the “break-even point.” Be sure you plan to keep your home for at least long enough to reach the break-even point, or refinancing may not be a good option for you.
If the cost of your loan is $5,000 and your monthly payment is lowered by $100 per month, you will reach your break-even point after your 50th payment, so a little over four years.
Common refinance fees
Don’t get blindsided by unexplained, confusing or unnecessary fees. Insist on full transparency and ask for a detailed explanation of every fee the lender charges.
Because Reali is a direct lender, we’re able to cut out the middleman and reduce fees. We also have real home loan experts to answer questions and concerns over the phone, always providing a 100% honest experience.
These are some of the fees that are associated with a loan refinance.
Origination fee: This fee covers the cost of processing the loan. Reali does not charge an origination fee unless the borrower chooses to buy points (see discount points).
Discount points: You can choose to pay this voluntarily, in order to reduce your monthly interest rate. Essentially, paying discount points is the same as paying interest in advance. The lender benefits by receiving money up-front, and you benefit by buying down your interest rate.
Each discount point costs 1% of the total loan amount, but can save you a lot of money over time — usually ¼ of one percent for each discount point you purchase. This may not sound like much, but it is.
For example, if you have a $200,000 mortgage with a 4.5% APR, two discount points would cost you $4,000 out-of-pocket, but save you $21,074 over the life a 30-year loan. That’s not a bad return on your investment!
Application fee: This is a catch-all term used to refer to a collection of fees. For example, the origination fee, appraisal fee, underwriting fee, document preparation fee, credit report fee, broker fee, and so on. If your lender lists an application fee, request the details about what individual fees it covers and which ones are negotiable.
Reali does not charge application fees.
Underwriting fee: This is a fee paid to the lender for doing the work to process your loan application.
Reali does not charge an underwriting fee.
Fees for services you cannot shop for:
- Appraisal fee
- Credit report fee
- Flood determination/certification fee
- Tax monitoring fee
- Tax status research fee
- Even some services you cannot shop for may be negotiable
Fees for services you can shop for:
- Pest inspection
- Title insurance
- Settlement agent fee
- Title search
- Hazard/homeowners insurance
Other fees you might encounter:
- Document preparation fee
- Administrative fees
- Funding/wiring fee
- Survey fee
- Mortgage broker fee
- Notary fee
- Release of lien fee
- Attorney fee
- Courier fee
- Recording fees
- Tax stamps
- Property taxes
There’s something all borrowers should know, called “fee tolerance.” Under federal law, certain fees that you pay at closing must match, exactly or closely, the fees shown on your Loan Estimate.
- Some fees may not change at all, including the origination fee, appraisal fee, tax service fee and HOA certification fee. The lender should know what these fees are and there is no excuse for changing them at closing time.
- Some fees can change by up to 10% at closing time, such as government recording fees.
- Some fees can change. Those fees include services you can control, like termite inspection, homeowners insurance, commissions, and prepaid interest.
Closing your loan
When the day comes to close your loan, show up prepared. You’ll be asked to sign many documents, including a contract to repay the money you’re borrowing, and a document giving the bank the right to take ownership of your property if you fail to pay.
You’ll also sign a closing disclosure. You should receive a copy of this document at least three business days before your closing date in order to give you ample opportunity to compare the final closing costs to those specified on your loan estimate.
Read every document, both to understand what you’re signing and to ensure no mistakes were made.
During the closing process, you may encounter the lender’s representative, a closing agent, a notary public and your attorney (if you have one).
Most of your required documents will already have been submitted, but you may need to provide evidence of homeowners insurance and a cashier’s check for your closing costs and any prepaid interest and taxes.
If you refinance the loan on your primary residence with a new lender, you’ll then have three days (not counting Sundays or holidays) after closing to change your mind and back out of the loan.
After the waiting period, the escrow initiates the transfer of funds from your new lender and the payoff of your old loan. Interest on your new loan begins the day your new lender wires the funds to your escrow agent. Interest on your old loan continues to accrue until the old lender receives the payoff from the escrow agent. You will pay interest on both loans for at least one day, and possibly more.
Your refinance loan
When you’re ready to refinance your home loan, reach out to Reali for more information, or simply connect with us (1-855-846-7334) to get your questions answered. Our home loan advisors are qualified, knowledgeable and provide you with a straightforward experience so you are well-equipped to help you make the best decision.